Should America Root for a Reforming China?

October 16, 2013 Topic: Economics Region: China

Should America Root for a Reforming China?

Xi might try making the PRC's economy more competitive. Good for the U.S.? It's complicated...

The Chinese Communist Party will hold plenary meetings in a few weeks, taking up the matter of renewed reform in the world’s second most important economy. While a grandiose announcement is guaranteed, China must have authentic and powerful economic reform to trigger another generation of rising wealth.

The catch is that what would be good for the People’s Republic of China (PRC) is not necessarily good for the United States. There are important ways in which the United States might be better off if the Party loses its nerve and economic reform is a fraud.

In the run up to the plenum, there has been plenty of debate over whether Party General Secretary Xi Jinping and the top leadership have the vision and authority to implement real reform. They will be opposed by the likes of extremely rich senior officers of state-owned enterprises, who also happen to be extremely rich senior members of the Communist Party. A question rarely asked is: whom should the United States root for?

The reflex answer is for the reformers. The American business community noticed the absence of reform about
five years late but is now crowing for it. More important, a more market-oriented Chinese economy means a good deal more market-oriented competition in the global economy.="#axzz2hatio5aa">="#axzz2hatio5aa">

Much as we sometimes dislike it, tough commercial competition—untouched by political intervention—is what creates prosperity. It improves quality, drives down prices, and spurs productivity and innovation. A genuinely competitive China will be good for the world.

Much as we sometimes forget it, the United States is not the world. A reforming China would help the world economy if its workers, firms and industries were successful in competing, without state assistance, in world markets. The benefits would come from these (as yet non-existent) superior workers, firms and industries displacing inferior ones, some of which would be American.

How important are the workers, firms and industries we could lose? The answer is somewhat worrisome. The United States has long taken for granted our leadership in technology,
and innovation more broadly. In the areas where we have been challenged, it’s always been by friends in West Europe or East Asia. The Soviet Union, for example, was nowhere close to a peer competitor in innovation.="#.ulsjglcshcy">="#.ulsjglcshcy">

The PRC is not anywhere close yet, either. It has been unable to assume a leadership role beyond a few, very narrow areas. Instead, it has imported, copied, bought and all too often stolen foreign technology.

To now. Another decade or two of true market reform could make China a competitor of the United States at the high end, over the next breakthroughs in telecom, biotechnology and energy. And China would be bigger economically than Japan or Germany, so competition would be broader. American consumers, and thus the American economy, would benefit from the new kinds of goods and services. This is no small development. But the American position at the top of the global economic, and perhaps military, heap would be seriously threatened for the first time in seventy years. It’s not obvious this is such a good thing.

The flip side is China fails to reform. The PRC today remains poorer and more vulnerable than perceived in the United States.

On official statistics, Chinese urban residents had close to $4,000 disposable income per person in 2012. For rural residents, it was in the neighborhood of $1,300. American personal disposable income was about $39,000 last year. It is true that prices are lower in China than the United States, but they’re not much lower anymore in many Chinese cities

At the national level, many commentators focus on gross domestic product (GDP) and the fact that, if Beijing’s statistics can be believed, China could match the United States in GDP by 2025 or even earlier. GDP is an annual measure, like a salary. To know how rich a person is, we don’t just look at a year’s salary. Similarly, to know how rich countries are, we have to look at all the assets they have, not one year’s output.

This is captured by wealth, not GDP. Credit Suisse has been estimating cross-national wealth for a while and their October 2013 report put total Chinese wealth at an impressive $22 trillion, just behind Japan’s. American wealth? $72 trillion. There are challenges to measuring wealth and, most likely, the Sino-American gap is not that large. Perhaps it’s only $40 trillion or $35 trillion. Regardless, it is immense. China has a long, long way to go to be in the same league as the United States.

And without reform, it will never happen. A lot of people have fallen in love with the PRC’s model of state-led development. In fact, it’s been a failure, something the Party will implicitly acknowledge at its big meeting.

At the end of 2002, China had implemented twenty-four years of market-oriented reform, capped by joining the World Trade Organization. An extremely poor country had become much better off, if still poor, and the prospects were good for continued gains. China’s economy was balanced between investment and consumption, debt was low, and ecological damage was considerable but not seen as crippling. Reform had succeeded brilliantly.

In 2003, a new government took over and the PRC implemented a new model, where state banks lent far more money to state firms, heavy industry rapidly expanded, and excess production was dumped on world markets. The result has been soaring debt, much more environmental devastation, and an unbalanced economy headed back to socialist levels of investment dominance over consumption.

Absent the mistakes of the past ten years, the PRC would face the daunting challenge of an aging labor force. If Beijing continues to insist on wasting huge amounts of money and trashing the environment, rather than enhancing labor flexibility and permitting real competition, growth will continue to slow. Then it will stop, even if government statistics pretend otherwise.

In other words, if China doesn’t reform, it will stagnate. Not today, not tomorrow, but soon, and possibly for the rest of our lives. A failure to reform drops China back to the pack, just as with Japan and the Soviet Union before. This would leave the United States as the undisputed world leader for decades to come (unless we repeatedly shoot ourselves in the foot, which is a story for another time).

This scenario is probably enough for many Americans to hope for Chinese reform to fail. Fair enough, but there’s a downside here too. If PRC stops growing by the end of the decade, it will still be big—second only to the United States, if well behind. It will still matter a good deal to the world, especially to Asia. And it may be angry.

Chinese Communist Party cadres are not a friendly bunch. They’re afraid of any alternative organization, including old people doing stretching exercises. They’ve siphoned off for themselves hundreds of billions of dollars in wealth. Their grip on power has inevitably rested on repression to some extent, but it has also rested on economic success. If that success disappears, what will the Party use to hold popular support?

Nationalism and confrontations overseas immediately come to mind. Beijing has a range of options for provocation—India, Vietnam, the Philippines, Japan and Taiwan. A nervous Party looking to rally the people has the capacity to make Asia a dangerous place for America and our friends and allies. Reform success or failure—pick your poison.

When the plenary meetings are over, there will be debate all over the world about what they mean, about whether China is back on the right path. The verdict eventually will become clear and it will no longer matter who to root for. Then the action will shift to the U.S. policy response.

A successful, reforming China will challenge America's economic leadership far more intensely than the mere hints of challenge seen to date. To meet that challenge, among other things, the United States will need to cut government spending and reform corporate taxation to spur innovation. A stagnant, tense China will challenge American security interests in Asia far more intensely than the mere hints of challenge seen to date. To meet that challenge, the United States will need to expand its military, economic and diplomatic commitment to the region, which will require a good deal of money and other resources.

November 2013 in Beijing will thus affect 2014, 2015 and many years to come. Get out your pom-poms and giant foam fingers.

Derek M. Scissors is a resident scholar at the American Enterprise Institute (AEI).

Image: Flickr/huiping ho. CC BY 2.0.